The Advisors' Blog

Allow me to introduce myself – Michael J. Album – a partner at Proskauer Rose practicing executive compensation law in the firm’s Employee Benefits and Executive Compensation Group. This is my first posting on this blog.

Following a tough week on 409A issues, I was having lunch in NYC with Arnold Ross and Norman Ross, principals at The Ross Companies, an exemplary benefits and executive compensation consulting firm. Arnold (father) and Norman (son) have about 65 years of compensation experience between them, and are quite knowledgeable in their chosen field.

During our conversation on compensation injustices, Arnold asked me why vested options generally expire within one year of the death and/or disability of the grantee, or in some cases within 180 days of the event. Norman politely pointed out that there should be no early expiration under such circumstances and the option should continue through to the end of the term. Anything short of a full term would simply be “punitive.”

How Do Companies Handle Death/Disability?

As we know, many companies either allow for a 180-day extension/exercise period or one-year extension/exercise period following the death or disability of the grantee. Some companies do provide for longer exercise periods. Some examples: at Chevron, the effect of death/disability on the expiration date of a stock option depends upon the age and length of service of the employee. Long term Chevron employee (i.e. one whose combined age and service total at least 90 or who is over 65 with at least one year of service) get accelerated vesting and retain the full term to exercise vested options.

Shorter term employees (i.e. those whose combined age and service total at least 75 or who are over 60 with at least one year of service) get pro rata vesting over a three year service period from date of grant and have five years to exercise their vested options or the remainder of the original term, whichever is shorter. All other employees forfeit unvested options at the time of death/disability and have only 180 days or the remainder of the original term (whichever is shorter) to exercise their vested options.

As stated in their 2008 Proxy Statement, Chevron’s policy of full/partial vesting (absent misconduct) is a “reflection of our belief that our equity and benefit programs should be based upon a career employment model ….” (See page 46 of Chevron’s proxy statement.)

At General Motors, vested options remain exercisable for the full remaining term under applicable retirement provisions; outstanding options vest immediately upon death and remain exercisable for three years from the date of death or for the remainder of the original term, whichever is shorter. (See page 48 of GM’s proxy statement).

Why Not Take a More Generous Approach?

The point of the approach taken by Messrs. Ross was this – the executive had assumed the risk of devoting his/her service to the issuer, and the issuer had an option on the executive’s work life – if the executive resigned prior to vesting, he/she suffered the economic risk through forfeiture of unvested options and a limited 90-day exercise period. Death/disability were involuntary events – why deprive the executive’s estate of the upside on the remaining option term?

I responded that the issuer was not an insurer, that it was “unfair” for the disengaged executive (or his/her estate) to benefit from the efforts of the new executives who stepped into handle matters and that the aggregate effect of “dead man”/“dead person” options could eat into available “head room,” making it more difficult to grant new equity to active employees. Companies would also be concerned about the administrative issue of dealing with widows and orphans holding options for the remaining term. Besides, this is the way it has been done for years.

Messrs. Ross shook their heads. Think out of the box. Sure the WSJ had just run an article highlighting criticism of huge cash “severance” payments to dead executives. But this wasn’t cash, this was equity. The number of dying/disabled executives was a limited universe – not likely to really affect available equity. The FAS 123R option expense changes were not going to be increased in any practical sense, since the traditional Black-Scholes “fair market value” pricing model uses company wide historical exercise data – which is not likely to be impacted by a few estates holding options to term.

– Michael Album, Partner, Proskauer Rose; Ishai Mooreville, a summer associate from the University of Michigan Law School assisted on this blog posting.